How to loose a zillion dollars (From WSJ)

For years, Alan Greenspan and the minded argued that allowing Wall Street to slice and dice loans and sell pieces as securities was an innovation that dispersed risks widely and made the financial system and the economy more stable. There's a lot to that. But as the loans leave the books of those who make them and are sold off in part to different investors, no one can be sure who holds the risk. If everyone fears that the other guy has a portfolio of toxic waste, markets freeze and the rest of the economy can be hurt. That in large part explains the behavior of big banks in the US and Europe since early August.
At some point the risks that greater opacity and complexity pose to financial stability offset the benefits of widely dispersing risks. Because what is in the clear interest of each individual player may not be in the interest of the system as a whole, market players aren't likely to get this balance right without at least prodding from government.

"Disperse risks widely" means nobody really cares how risky the deal is, 'cause their money isn't at stake. How good is any particular mortgage? Only the loan officer granting the loan really knows. Nobody else has a clue. The whole idea of mortgage is the lender can seize the property and sell it if the borrower defaults on his payments. This doesn't work if the house isn't worth the face value of the mortgage. You don't want to issue $100K mortgage on a dog house or a two car garage.
So how much is a property really worth? The loan officer guy has to know the local real estate scene. He has to know the good locations from the less good, which takes local knowledge. For instance he has to know that Melrose is a better location than Malden, Wakefield, Stoneham and Saugus, or that Cambridge is better than Somerville. Then he has to decide if this couple can make the mortgage payments based on what they earn now, and the likelihood of of a layoff, a pregnancy, a divorce, a death, or disablement.
If the loan officer is loaning his own money, he will be quite prudent. If on the other hand he plans to sell the mortgage to Bear Stearns or Merrill Lynch as soon as he can, then he doesn't care so much. If the mortgage goes sour it's no skin off his nose (or money out of his pocket). If he gets paid closing costs, then he will be inclined to OK nearly anything, he wants those closing costs, and since risks have been "dispersed", why not approve just about any loan?
One other effect of reckless mortgage lending. It allows the price of houses to rise. House prices are limited by how willing the bank is to grant a mortgage. The house doesn't sell without a mortgage, so to a large extent the mortgage lenders hold down the price of houses by refusing to grant mortgages on overpriced dwellings. Remove this constraint and the price of housing climbs.